Huadong Medicine (SZSE:000963) Seems To Use Debt Rather Sparingly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Huadong Medicine Co., Ltd (SZSE:000963) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Huadong Medicine

What Is Huadong Medicine's Net Debt?

As you can see below, at the end of March 2024, Huadong Medicine had CN¥1.60b of debt, up from CN¥1.38b a year ago. Click the image for more detail. However, it does have CN¥3.56b in cash offsetting this, leading to net cash of CN¥1.96b.

How Healthy Is Huadong Medicine's Balance Sheet?

According to the last reported balance sheet, Huadong Medicine had liabilities of CN¥10.9b due within 12 months, and liabilities of CN¥1.06b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.56b as well as receivables valued at CN¥11.0b due within 12 months. So it actually has CN¥2.58b more liquid assets than total liabilities.

This short term liquidity is a sign that Huadong Medicine could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huadong Medicine boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Huadong Medicine grew its EBIT by 11% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huadong Medicine's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huadong Medicine may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Huadong Medicine produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huadong Medicine has net cash of CN¥1.96b, as well as more liquid assets than liabilities. And it also grew its EBIT by 11% over the last year. So is Huadong Medicine's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Huadong Medicine is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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